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2011 Transfer Pricing Proposals: Secondary Adjustments – Will We Pay Double Tax?

02 June 2011   (0 Comments)
Posted by: Author: Christian Wiesener
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2011 Transfer Pricing Proposals: Secondary Adjustments – Will We Pay Double Tax? 

The Draft 2011 Taxation Laws Amendment Bill was published for public comment on 2 June 2011. Following the announcements made by Finance Minister Pravin Gordhan in this year’s Budget Speech, several interesting amendments to the tax acts were expected. However, reviewing the 190 pages of currently proposed 2011 amendments and the just short of 130 pages Draft Explanatory Memorandum, taxpayers are surprised by yet another amendment of the South African transfer pricing rules. 

The 2010 Taxation Laws Amendment Act saw the most significant changes to the South African transfer pricing legislation since its introduction in 1995, which were promulgated with effect for years of assessment commencing on or after 1 October 2011. Further changes were not anticipated.

In the latest proposals, the South African Revenue Service (SARS) will have the power to make secondary adjustments to transfer pricing adjustments. The current South African transfer pricing rules provide SARS only with the discretionary power to adjust the income of a taxpayer. Any transfer pricing adjustment triggers a deemed dividend. The draft Explanatory Memorandum to the 2011 Draft Taxation Laws Amendment Bill clarifies that the automatic deemed dividend rules stemming from a transfer pricing adjustment will not be carried over to the new dividend tax regime, which will be introduced shortly. 

SARS will, however, in terms of the proposed amendments, have the discretionary power to create a deemed dividend as part of a secondary adjustment. SARS powers are significantly extended.

A secondary adjustment follows a primary adjustment.  A primary adjustment changes the allocation of taxable profits between a South African taxpayer and its foreign connected person to reflect an arm’s length price for the relevant transaction. In addition, a secondary adjustment achieves the result that the excess profits represented by the primary adjustment are treated consistently with the position had the original transaction been entered into at arm’s length. 

For example, if, in terms of the proposals, a South African company undercharges for goods sold to its foreign holding company, the taxable income of the South African entity would be adjusted to reflect an arm’s length (market related) price for the sale of the relevant goods (primary adjustment). 

However, the additional income arising from selling the goods at the arm’s length price would then have been available for the South African company to have also declared a dividend. Normally, secondary tax on companies (or dividend tax once effective) is levied on the distribution of a dividend. This is, in terms of the proposal, achieved by making a secondary adjustment that is an adjustment arising from imposing tax on a secondary transaction. However, one of the problems with secondary adjustments is that while agreements for the avoidance of double taxation generally provide relief regarding a primary adjustment in the form of a corresponding adjustment in the other country, such relief is not available regarding secondary adjustments. 

Some countries avoid the issue of potential double taxation on the secondary adjustment, for Canada, by allowing repatriation of the excess funds back to the taxpayer against whichthe primary adjustment was made. This means that the repatriation effectively results in the cash to be repaid so that the accounts of the parties involved are consistent with the economic intent of the primary adjustment. 

The Organisation for Economic Co-operation and Development (OECD) acknowledges that repatriation allows a taxpayer to conform its accounts to the primary adjustment. This  could be effected either by setting up an account receivable or by reclassifying other transfers, such as dividend payments where the adjustment is between parent and subsidiary, as a payment of additional transfer price (where the original price was too low) or as a refund of transfer price (where the original price was too high). 

The issue of secondary adjustments is controversial in the global transfer pricing arena and the OECD encourages tax administrations, if they consider it necessary to perform secondary adjustments, to structure these with a view to minimise potential double taxation. While it is accepted that the potential of multinational enterprises shifting their profits to tax-friendly jurisdictions has created the need for stringent transfer pricing regulations around the world and in South Africa, revenue authorities also often use transfer pricing as a mechanism to facilitate increased revenue collections. 

Transfer pricing proposals should be considered carefully by the authorities here to ensure that no unnecessary burden is placed on taxpayers engaging in international trade particularly at this time of economic recovery.It should be considered whether secondary adjustments are necessary and whether SARS should have the discretion to make or not to make a secondary adjustment.

Source: By Christian Wiesener (TaxTALK) 


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